More Effective Valuation Review Strategies

Adapting to a more risk-focused valuation review process can enable lenders to close real estate deals faster while ensuring that they meet regulatory standards. Here are four “Cs” to keep in mind to strengthen your valuation-related review strategies: 

The First ‘C’: Comply with Regulatory Expectations 

There are two key regulatory references regarding the scope of the review process. The Appraisal Regulations i require appraisal reports to “be subject to appropriate review for compliance with USPAP [Uniform Standards of Professional Appraisal Practice].” ii The Interagency Guidelines iii discuss applying appraisals and evaluations to an independent and “risk-focused review process that is commensurate with the size, type, and complexity of the underlying credit transaction as well as loan and portfolio characteristics.”  

In addition, there are three key regulatory references that discuss addressing material errors in reports. The Reconsideration Guidance iv states the Federal financial institutions’ regulatory agencies “…prohibit the use of an appraisal that contains material errors.” v The Truth in Lending Act (TILA)vi requires financial institutions to refer appraisers when they reasonably believe an appraiser has not complied with regulatory requirements “if the failure to comply is material.” Fannie Mae states “any request for a change in the opinion of market value must be based on material and substantive issues.” vii While these references pertain primarily to residential loans, financial institutions can apply their concepts to agricultural and commercial real estate transactions.  

Unfortunately, none of these sources clearly define what constitutes a risk-focused review process or a material error, or describe the circumstances when financial institutions should request revisions to appraisals or evaluations. Although lenders have established general criteria in this regard, the ambiguity has led to more comprehensive reviews than are warranted as well as unnecessary interactions with appraisers on minor issues, reducing productivity for both the bank’s staff and the appraiser and increasing costs.  

The Second ‘C’: Crack the Problem 

Ordering credible, standardized, and compliant appraisals, evaluations—or validations of existing appraisals from vendors who produce good quality reports—is often the most cost-effective and efficient review process. These valuation reports should be subject to a risk-focused review. Here are three ways financial institutions can optimize their valuation review process to ensure reports provide reliable market value information in a timely manner to close the loan.  

Implement a Three-Tier Review Process. Many lenders’ appraisal review procedures typically default to using one of two standard review forms. This practice involves completing either an administrative or compliance review form for less complex or lower dollar transactions or a technical review form for complex or higher dollar transactions. While acceptable, this approach is less efficient than a technology-assisted review. At the same time, while technology can accelerate the process, human judgment remains essential to ensure accuracy and credibility. A three-tier system offers a smarter, risk-focused review strategy.  

• Tier-One – Semi-Automated Review. Start with an automated check of critical, objective criteria, including basic USPAP requirements. The review process should then populate a standardized form that summarizes key data and flags inconsistencies. Institutions can build a technology-assisted review with various existing programs, including generative artificial intelligence (AI). When using an advanced tool, users need to understand how it works and routinely verify that the outputs are accurate and consistent.  
  A semi-automated review that is commensurate with the size, type, and complexity of the underlying credit transaction could suffice as an appropriate review for compliance with USPAP for low-risk real estate transactions, such as credits that have a low loan-to-value ratio. Qualified personnel should conduct an expedited check of whether the output from the semi-automated review is appropriate and sufficient for the specific transaction.  When this procedure flags an issue, the system escalates the pre-populated form to the Tier-Two level and a trained reviewer completes the next phase in the process.  

• Tier-Two – Administrative Review. Conduct the Tier-Two review when the transaction either does not meet the Tier-One threshold criteria or is flagged during the Tier-One review. The process results in a checklist approach with brief comments and limited, if any, interaction with the appraiser or evaluator. This approach is generally satisfactory for loans that exceed the Tier-One criteria and the real estate is not an overly complex or a special purpose property. When this procedure flags an issue, the system transfers the pre-populated form to the Tier-Three review function for a more seasoned reviewer to consider. 

• Tier-Three – Technical Review. Escalate to the Tier-Three review when the transaction either does not meet the threshold criteria or is flagged during the Tier-Two review. The process results in a more comprehensive exercise with more extensive comments to address specified USPAP issues. It also will involve more interaction with the appraiser when it triggers a “materiality” test, as discussed below.  

Appraisal Standards Board Advisory Opinion (AO) 41. For a Tier-Two and Tier-Three review, if the semi-automated review process was based on one or more advanced technological tools, then: 

• Understand that a user who is not an appraiser is not subject to AO 41 although the user should know how the advanced technological tool(s) works.  

• Recognize that a user who is an appraiser is subject to and should comply with AO 41 by understanding the tool well enough to recognize when outputs are accurate or potentially misleading. This includes awareness of limitations, biases, and assumptions embedded in AI or statistical.   

Errors. Watch for potential errors in generative AI models and other advanced technological tools, such as: 

• Experiencing hallucination, fabrication, misalignment, and assignment drift. 

• • Hallucination: The AI presents information as factual even though the information is not contained in, or supported by, the appraisal or other authorized source documents. Example: Stating that a property has environmental contamination when the appraisal does not report contamination. 

• • Fabrication: The AI invents a specific fact, calculation, citation, quotation, source, or finding that does not exist. Fabrication is generally a more concrete form of hallucination. Example: Creating a nonexistent appraisal page reference, comparable sale, zoning requirement, or appraiser conclusion.

• • Misalignment: The output does not properly follow the assignment instructions, review criteria, intended use, required format, or source limitations, even if portions of the output are factually correct. Example: Reporting minor grammar issues as material valuation findings when the instructions limit material findings to matters affecting credibility, compliance, reliability, or internal integrity. 

• • Assignment Drift. The AI gradually moves beyond the defined scope or purpose of the assignment and begins performing a different task. Example: Instead of reviewing the appraisal for accuracy and compliance, the AI begins developing an independent value opinion, researching external market data, or recommending loan terms. Examples: 

• • • Misapplying or misinterpreting USPAP requirements, regulatory guidance, or generally accepted appraisal methodologies, resulting in analytical conclusions, reporting, or valuation procedures that are not adequately supported or consistent with professional appraisal standards. 

• • • Concluding that no issue exists solely because average gross adjustments fall below a prescribed tolerance threshold, without recognizing that an individual adjustment exceeding the threshold may warrant further analysis or affect the reliability of the comparable sale. 

• • • Failing to recognize that selected comparable sales are not truly comparable to the subject property due to inconsistent highest and best use conclusions, materially different market characteristics, or other factors that undermine comparability and the reliability of the analysis. 

• • • Identifying limitations or “blind spots” within automated review tools that may fail to detect inaccurate, unsupported, or misleading information when the same error, assumption, or inconsistency is applied uniformly throughout the appraisal report. 

• • • Determining whether extraordinary assumptions or hypothetical conditions, although properly disclosed and labeled, are appropriate for the assignment and correctly applied within the analysis, including identifying instances where such conditions may be unsupported, unnecessary, or improperly relied upon in developing the valuation conclusions. 

Set Materiality Tests. Materiality tests establish thresholds that permit reviewers to accept minor mistakes without contacting the preparer. This approach enables reviewers, appraisers, evaluators, and vendors to spend their time on what really matters—errors that potentially raise legal concerns or materially impact the value conclusion. Materiality tests could provide parameters that address three types of issues: 

1. Identify and correct significant factual mistakes in legal information, property characteristics, legal description, owner names, address, county, zoning, regulatory definitions, and/or appraiser certification. Minor factual errors can be addressed in comments to the extent necessary. 
2. Investigate any allegations of appraiser bias or discrimination whether internal or external. 
3. Establish benchmarks to determine when the cumulative effect of aggregate errors that impact the value conclusion is material. For example, lenders establish a percentage criteria, such as aggregate errors that impact market value by 5% or less are accepted –– NO REVISIONS ARE REQUESTED.  

Consider Reviewer Qualifications and Independence. The Interagency Guidelines describe basic criteria for reviewers and the review process. For appraisals, a qualified reviewer, who may or may not be an appraiser, should assess the report’s accuracy, completeness, compliance with USPAP, Interagency Guidelines, and internal policies to determine if the report is acceptable. For evaluations, a qualified reviewer should consider whether the evaluation contains sufficient information to support its opinion of the market value. Regardless of the type of report, the reviewer should be independent of the transaction and not be subject to undue influence from loan production staff or other parties involved in the transaction.  

The Third ‘C’: Consider Pros and Cons 

As with all valuation-related decisions, lenders should consider the pros and cons of updating their valuation review strategies.  

Cons. Modernizing the review process has some drawbacks, such as issues around: 

• Defining Material Errors. Regulatory ambiguity of what constitutes a material error does not provide a clear legal defense for an organization’s definition.   

• Addressing Errors. Some borrowers may express concerns if a lender accepted an appraisal or evaluation with known minor errors, even if the impact on market value is negligible. 

• Incurring an Initial Cost. Developing a semi-automated review process may require some upfront costs, including production of a pre-populated review form, but would reduce costs immediately after implementation.  

Pros. Modernizing the review process has many benefits, including these areas: 

• Defining Material Errors. Establishing clear criteria for what constitutes a material error is consistent with regulatory expectations.   

• Acknowledging Errors. Despite reasonable quality controls, some appraisal or evaluation reports provided to a borrower may contain errors. A transparent acknowledgement puts all parties on notice that immaterial mistakes may exist in a valuation product, which may be raised through the reconsideration of value process.   

• Reducing Costs. Adopting a three-tier review system with materiality tests will reduce operating expenses by minimizing staff time spent reviewing reports for low-risk transactions or following up on minor issues.  

The Fourth ‘C’: Conclude by Implementing an Effective Strategy 

A robust valuation review strategy leverages accessible, well-understood technology to support a three-tier review function. Whether reviews are conducted in-house or outsourced, institutions must ensure that reviewers possess the requisite expertise, maintain independence, and operate free from undue influence. Establishing risk-based materiality thresholds for requesting revisions focuses reviewer attention on substantive issues, preserves regulatory compliance, sustains report quality, and reduces staff time historically consumed by immaterial corrections. Strengthening these components produces a streamlined, defensible review program that delivers measurable benefits to lenders, appraisers, and borrowers alike. 

[i] The Dodd-Frank Wall Street Reform and Consumer Protection Act mandated that the Appraisal Regulations had to require a review, which became effective October 9, 2019. See at eCFR :: 12 CFR Part 323 — Appraisals.

[ii] See the Uniform Standards of Professional Appraisal Practice (USPAP) at 2024_USPAP_STANDARDS_1-4.pdf.

[iii] See the 2010 Interagency Appraisal and Evaluation Guidelines (Interagency Guidelines) at Interagency.

[iv] See at Interagency Guidance on Reconsiderations of Value of Residential Real Estate Valuations.

[v] See 12 CFR 34.44 (OCC); 12 CFR 225.64 (Board); 12 CFR 323.4 (FDIC); and 12 CFR 722.4 (NCUA).

[vi] Under the Truth-in-Lending Act (TILA), if at any point during the lending process the financial institution reasonably believes that an appraiser has not complied with USPAP or ethical or professional requirements for appraisers under applicable state or Federal statutes or regulations, the financial institution is required to refer the matter to the appropriate state appraisal regulatory agency if the failure to comply is material. See at eCFR :: 12 CFR 1026.42 — Valuation independence.

[vii] See at Appraisal Quality Matters | Fannie Mae.